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Bitcoin, the digital currency launched in early 2009, is being accepted by an increasing number of vendors worldwide, from car dealerships and online travel-planning firms to wine merchants and charities. Even though its value has swung wildly in recent days, each bitcoin has skyrocketed in value for the year overall, climbing from around $13.50 last Dec. 31 to above $1,000 as of yesterday, according to data from bitcoincharts.com.

But will bitcoin's growing acceptance undermine the U.S. dollar? The short answer is no.

Certainly, there are investors out there who worry about the dollar, and especially how unintended consequences from easy monetary policy and massive government debt might undermine the U.S. currency. How could it be that the Federal Reserve's balance sheet has risen by more than 300% since 2008 and the dollar has not been debased?

Frankly, the dollar has never displayed a strong, consistent relationship with the Fed's balance sheet or the growth in, or the absolute size of, the U.S. federal debt. Instead, the dollar is driven mainly by trends in a country's balance of payments—that is, the current and capital accounts. Dollar weakness occurs most frequently when the U.S. current account deficit is widening (Americans are selling more dollars to pay for foreign goods than they receive for U.S. goods sold overseas) and/or when a lot of U.S. capital is heading abroad (to buy foreign stocks, bonds or for direct investment in foreign companies). U.S. monetary and fiscal policy influences these flows, but to different degrees at different points in time.

Whatever the reality, perceptions of the dollar do seem to have deteriorated in recent years, in part because of U.S. policy. If dollar-wary investors were switching over to bitcoins, we would expect to see signs of stress in currency markets. That's not the case today. In fact, the trade-weighted dollar has strengthened about 4% in the first 11 months of 2013, while implied volatility in major currency pairs has held well below historical averages.

Maybe the dollar is not under threat from bitcoins now, but could it be in the future? Financial markets teach you to "never say never"—over the centuries, dominant currencies have come and gone. One cannot rule out the possibility that the dollar someday loses its status as the world's reserve currency, or at least has to share that global stage.

Bitcoin is a long way from reserve-currency center stage, in our view. Indeed, it's still auditioning to be considered a currency at all. Reserve currencies are easily traded—which requires ample liquidity and controlled volatility. Bitcoin, for now, has neither characteristic. The value of balances in bitcoin reportedly stands around $1 billion, versus an approximate $1.2 trillion circulating in U.S. dollars. That relative lack of liquidity exacerbates volatility—just this year, the cyber currency traded around $230 in April then fell below $70 in July, before skyrocketing to over $1,230 earlier this month (and then back to around $1,000 on Wednesday).

Bitcoin also lacks another characteristic of reserve currencies: confidence, which is usually created through sound monetary policy and regulation. Bitcoin is backed by an expectation that the encryptions behind the digital currency can't be hacked. So far, regulators are still exploring bitcoin; indeed, the U.S. has not even decided if bitcoin should be treated as a currency or a commodity. This is not to say that bitcoin would have to be highly regulated to succeed. However, for it to be considered a true currency alternative with broad-based, global use, we would expect it would need the credibility that would come from some governmental or other multinational authority's backing.

There is also a question around supply. Confidence in bitcoin is backed by its founders' word that supply will ultimately be limited to 21 million bitcoins—the hope being that limited supply will help support the price. However, as a recent newswire analysis showed, the number of bitcoin copycats is increasing rapidly. As of end-November, 37 different bitcoin-like currencies were actively trading, including the "Franko" and the "Craftcoin."

Further, financial firms, eyeing bitcoin, are exploring their own means of electronic payment. As an example, the Financial Times newspaper reported this week that
JPMorgan ChaseJPM 0.1942690626517727%JPMorgan Chase & Co.U.S.: NYSEUSD61.89
0.120.1942690626517727%
/Date(1425413431667-0600)/
Volume (Delayed 15m)
:
8478281
P/E Ratio
11.365808823529411Market Cap
230297894992.819
Dividend Yield
2.5877405790069545% Rev. per Employee
406463More quote details and news »JPMinYour ValueYour ChangeShort position
(ticker: JPM) had filed a U.S. patent application for an electronic payments system that resembled some aspects of bitcoin. To the degree users are open to other forms of cyber currency, total cyber currency supply will grow quickly, and well beyond just what bitcoin expects. This could weigh on future price gains for bitcoin. Investors could easily try to take profit on bitcoins to buy cheaper Frankos, for instance, especially if these currencies are able to perform similar functions in the marketplace and are seen as generally fungible.

In our view, bitcoin is less a statement about the dollar, the Federal Reserve and Washington, and more a statement about China. According to recent news reports, China's bitcoin market volumes grew very quickly this year, and today account for about two-thirds of global bitcoin transactions. The Chinese are flocking to bitcoin for a good reason—they do not have many investment alternatives besides domestic bank deposits and real estate. China continues to have a closed capital account; that means most Chinese cannot simply sell their renminbi for foreign currencies (or foreign stocks, bonds or other assets).

Bitcoin gives the Chinese something they can use to diversify (and hopefully) grow their wealth. But this past week, China's central bank seems to have woken up to this capital-account loophole. It announced that Chinese financial institutions would not be allowed to transact in bitcoins and that any online bitcoin exchange would have to file trading records. Partly in response, the Chinese internet search-engine firm Baidu said Friday it would at least temporarily stop accepting bitcoin as payment for one of its services.

Whether encouraged or not in the U.S. or China as a real currency alternative, bitcoin may well survive—even thrive—as a means of electronic payment. Looking at the U.S. dollar's future, meanwhile, we remain fairly sanguine. To the degree a challenge for the world's reserve currency lurks, we think it is many years away. The euro could become a threat for the dollar, but only if national bond markets were harmonized to allow them the depth and liquidity equal to U.S. Treasuries. The other potential contender is the Chinese renminbi, but only if China were to fully open its capital account and deepen its domestic bond market, an act that in itself could well undermine bitcoin, not the dollar.